Licensing and Other Options: the Entrepreneur's Dilemma

(For further information, see the legal articles at the end of this discussion.)

Partnership? Limited Partnership? Franchising? Licensing? How do I expand my business? What are the options? And what is "licensing" as opposed to "franchising?" What really are the different alternatives? Branch location? Partnership? Franchise? What is the best method to employ in order to expand my business?

If you open a branch location, you will need to hire employees and managers. You will have direct control, but increased direct responsibilities. It will also require use of your own capital and might spread your own time dangerously thin. Maybe this is not a big problem if you open just one branch. But what if you want to expand to three? Or five? Or ten?

The more branches, the more employees, the more paperwork, the more capital cost, and the more chance of hurting the main business that you have worked so hard to build.

Even if these problems are largely solved, can managers be found who will care about the business as much as you do? Not likely. And the problem gets worse with every passing decade. It gets harder and harder to find responsible employees, and almost impossible to find good managers. Maybe profit sharing or work incentives will provide the needed inspiration and desire. But you will still have that daily, direct responsibility and capital outlay to spread out over a number of locations.

Perhaps you should get a partner to share the responsibility and expense? That should solve the problem! But then, partnerships aren't easy, being much like a marriage (without the chance to kiss and make up). How do you find the right partner? Is there such a thing as a right partner? At least in a marriage, love is involved. In partnerships, the squabbles are nakedly, openly, and totally about control, direction, and sharing of time, responsibilities, and, most divisive of all, money. When is the last time you saw a partnership that worked? Even if you found one good partner, will you be that lucky in expanding to numerous locations? The statistics are not good.

How about limited partners? Limited partners only provide capital. This should solve the "marriage" dilemma! But, then, they will likely stick their noses in to protect the investment. They get to meddle, to question, to interfere without being responsible. That part doesn't sound too good.

As to franchising, I'm sure you keep hearing about problems with quality control, control over the daily business operation, problems with franchisees, and, even lawsuits. It all sounds kind of negative. Exactly. It is negative. And the reason you keep hearing these negative comments is that everyone thinking about franchising asks the same thing: "Franchising sounds good. It seems to solve most of the branch location and partnership problems. But, what are the negatives?"

That is when the costs, quality control, management and legal problems seem to overwhelm the discussion. Think about it. What enterprise is free of these problems? Partnerships? Not likely. Sole proprietors, corporations and partnerships still have all of the negatives that we have already discussed.

Issues and Solution in Expanding Your Business

Let's examine some of the major areas of concern in business and marketing expansion.

Management

Who makes a better manager? Someone whose resume looks good? Or, is it someone similar to yourself: an entrepreneur that invests his or her personal time, money and future in the business.

Quality Control

In all other forms of expansion, you have a list of rules and procedures for each location and hope that you can enforce them. In franchising you have a written agreement that demands compliance and allows you to get rid of those who don't comply. Once again, the one that puts his or her own time and money into the business is more likely to maintain the quality of the product, service and the franchised location.

Employees

Go ahead. Expand from one location and five employees, to ten locations and fifty knuckleheads. Talk about problems! They don't expand in a linear manner, they increase exponentially. The problems expand at a much faster rate than the employee base. Why not let your franchisees handle their own withholding, wage and hour laws, sick time, jury duty, and the hundred other situations?

Expansion Capital

Let me see. How can I put this so it doesn't sound stupid? Do you look forward to investing your own personal capital into 15 locations where you are at the mercy of the local management and employees? Or, do you think it might be better to let someone else provide that capital (and assume the local headaches)? Sorry. There is no other way to say it. We could discuss dozens of areas where the existence of a personally-involved, emotionally committed, entrepreneurial-minded franchisee is the better of almost any option you can propose.

A Legal Primer on Franchising:
Four Important Articles

An excellent article on Unsuspecting Franchisors: a discussion of the definition of the elements which ordinarily result in being defined as a franchise.

What Makes it a Franchise?: More discussion of the definition of the elements which ordinarily result in being defined as a franchise.

An excellent article on Sending Disclosures by Disk: a discussion of Offering Circulars provided by other than written documents.

A discussion of all the basic requirements for offering franchises: Franchising 101.

Why Aren't You Franchising?

If franchising is the grand solver of expansion problems, then what is it that discourages its use? It is easy to blame irresponsible franchisors who expand too rapidly and thereby fail to provide the services they promised to franchisees. These are the ones who let the system get away from them. The resulting failure to help, and failure to communicate, inevitably leads to breakdown and lawsuits.

Franchisors that develop their system slowly, that control growth to permit the provision of full franchisee services and meaningful communication, never have these problems. If you are among this group, you realize that the real value of a Franchising system lies in contented, prosperous franchisees who submit an increasing amount of royalties month after month and year after year. You know that their success is your success.

Those other guys, who think that initial franchise fees are the answer, just don't understand the situation. They mess up the whole pot for everyone else.

You are one of those that understand these concepts.

What, then, keeps you from franchising? Lot's of things. Fear of the unknown. Expense of developing the documents. All those federal and state rules about franchising. And, the time it takes away from your existing business.

The Franchise Company Can Guide You through the Process

If you stop to think about it, the same things that keep you from becoming a franchisor, are basically the same things that keep people from starting their own businesses. They are afraid to fail and are uncertain how to accomplish the goal. That is why most people would rather invest in an existing franchised business, than take a chance on their own. You show them how to do it and hold their hands while they gain their own experience and abilities.

In a franchising sense, The Franchise Company is you, and you are the franchisee. We assume the burden of preparing the required documents. We prepare the manual, show you how to do a brochure and help you through the initial phases of marketing and sales. We hold your hand through the whole process. You gain the necessary knowledge and experience by relying on us to show you how. Once you know how, it is always easier. Then you can help others be successful like you.

We would appreciate the opportunity to guide you through the franchise development process.

The Licensing Option

One alternative expansion method deserves special attention. Many companies feel they have found a way to avoid the complications of franchising by labeling their program as "licensing." This often misguided belief usually flows from bad advice from some attorneys or uninformed consultants. At best, the effort to expand to multiple operations by service mark or trademark "licensing" is a dangerous venture if you intend to maintain any control over the operations of the licensee.

Franchising systems are designed to enhance the goodwill (value) of the franchised product or service. A trademark licensed to numerous franchisees is hopefully enhanced by multiplied sales of the products or services, wide-spread common advertising and the other beneficial characteristics that result in increased name recognition. In order to insure that the increased name recognition is accomplished in a positive manner, it is necessary to establish controls over the operations of the licensee and the quality of the service or product. In doing so, there are basically two choices: (1) control only the quality of the product or service; or (2) control that quality and also establish controls on the operation of the licensee's business.

If only the quality of the product or service is controlled, the arrangement is a license, and not subject to the franchise rules. If a product is being manufactured and sold, this is usually fine. You can perform periodic quality tests to be certain your strict requirements are being met. (Unless, of course, you issue more than one license. Then you must worry about violating this exception as well).

In any event, what about service to the customer? How about the cleanliness of the business premises? Are they meeting local health regulations? Are OSHA requirements being met? Are they following up to insure customer satisfaction? Hopefully, when you attempt to build goodwill, it turns out to be goodwill. Unless you have proper controls and demand compliance to your operating standards, you aren't building anything for certain, and you may be building harm.

If you do have the proper controls, then you are franchising, no matter what you choose to call it.

Primary Difference between Licensing and Franchising

The primary difference between simple trademark licensing and package franchising is in the type and degree of control exercised by the franchisor and licensor. The trademark licensor is interested in the quality of the final goods produced by the licensee, not in the licensee's method of operation. The kind of control he exercises is thus likely to be limited to "passive" control such as inspection of produced goods and testing to insure that quality standards are being met. Package (or "business format") franchising, on the other hand, involves active control over the franchisee's "method of operation": The location of the business, the hours of operation, the management of the business, and other business matters.

There is only one sure way to build goodwill and value to your business through a license. It is called franchising.

Even if you successfully arrange a licensing system that exempts you from federal law, what about state laws? The definition of a franchise under most state laws is broad and encompassing. You may satisfy FTC requirements and still be a franchise under state definitions. We will be happy to discuss the benefits and dangers of franchising 'alternatives.'